My Aftermath Outlook

If I had a gold coin for every remark or opinion I have thus far read about
what hurricane Katrina will do or won't do to the strength or weakness of the
US economy and what the Fed will do or won't do at their next FOMC meeting
on the 20th of September in terms of raising, holding or lowering interest
rates and what the effect of their having done so or not having done so will
have on the gold prices, consumer confidence and the yield curves, then I would
have shut down this Letter and site immediately and retired to a comfortable
place in Toscana, Italy, or maybe, Tirol, for I would already be a millionaire
in gold - that is the number of remarks and opinions I have read in the last
nine or so days after Katrina.

I summarize for you, and myself, what I think more aptly describes the situation:

"Too many promises weakens one belief"Jewish Proverb

And we've heard a lot of promises lately: The levees will hold, no need to
worry, the oil supplies are OK, no need to worry, we'll be out of Iraq in 6-8
weeks, we'll be pulling out the troops soon, the US Dollar is strong, on and
on... Is anybody weakening in their beliefs yet? I certainly am assuming I
ever believed those examples above in the first place. I could go off onto
a foray on this subject alone citing examples from Mises, Rothbard and others
on the folly of the State but I think we all get the point. Time for independent
study and thinking has never been greater.

Although I'm sorry to say, one of the hollow "victories" I did have in observing
the world financial markets, and I admit it's hollow and perverted in a twisted
sort of way, only because it happens to have taken place and caused so much
terrible pain and suffering, is that a shock to the financial system has occurred.
Whether the shock was via hurricane Katrina, or had been some other event at
some other location, e.g. a terrorist event, or an "Iran event", the point
I was trying to make was that the world financial community has been living
a rather complacent and wishful-thinking existence and that many of the financial
instruments in the markets are not "shock resistant" and ever more so in an
imbalanced macro world. Things are not properly risk managed. Equally, the
entire fossil fuel energy complex, the true Achilles heal of the world economy,
has shown itself to be vulnerable although be no means tumbling out of control
yet. And that means the entire world is vulnerable - with increased demand
and limited supply, I have always contended that is was only a matter of time
before something of this nature might occur. Could Iran be next? What about
Russia? What about a major earthquake in California? If you do not have some
energy in your portfolio then I think you might ought to think about it. I
still believe it is not too late to add incrementally into as long as due diligence
and research in your portfolio additions is undertaken. I shall be including
a number of additions which I think are reasonable in the coming months ahead.

Here are a few interesting energy and bi-lateral trade facts currently
underway:

Although the recent price shocks to the gasoline prices may inevitably hurt
the consumer, a recent survey showed that people in the US are still willing
to buy petrol-guzzling SUVs, since 1990 the US has increased energy imports
by around 60% - as you may know, the US GDP is mostly centered around personal
consumption, in fact it is around 68%, Saudi has just come out and asked OPEC
to pick up capacity levels (they no longer can as their fields have already
peaked in production - the worlds number one supplier), Russia has now signed
a deal with Germany to build a gas pipeline across the Baltic Sea to deliver
natural gas - likely not a deal done in US Dollars, in March 2006 is planned
the opening of the Iranian Oil Bourse and will enable transactions in both
oil and gas - again, not likely to be done in USD - and in direct competition
to other exchanges in the West, With Iran one of the largest holders of oil
reserves, is it any wonder the US interest in the Middle East region - again,
the Iraq War was a snow job about terrorism and Saddam and liberty and democracy
- very simply it was and is about oil, any other considerations and I suggest
attending Geopolitics 101 at your local educational institute - Empires don't
operate on petrol fumes. What Iran and its partners like Russia and/or China
are doing is splitting the common denominator of all commodity transactions
- the Empire US Dollar. Once this happens, it reduces the need for nations
to bunker USDs in order to get their raw energy goods and commodities they
require to operate. This in turn reduces the need to buy US Treasuries and
with the US trade and deficit overhang nowhere being addressed, it does not
look good for either the USD or the US consumer, especially if consumer centric
GDP must contend with rising interest rates to attract USD buyers. Therein
lies the real shock potential over the horizon.

This is all happening in slow-motion. You will not read about this in the
press. But it is a geopolitical puzzle happening in real-time. The "now story" may
be Katrina but the real story is yet to be told as mainstream press is usually
far behind. Researching hundreds of publications takes a lot of my time. Another
side-story to this is the amount of trade that China and the US have with one
another and thus China being export vulnerable. They have recognized the two-edged
sword and thus decided to float the currency in time for diversification. Equally,
a recent statement from a Chinese financial advisor is their intent to raise
trade with the EU and thus diversify away from pure US consumption. This carries
added risk for the US Dollar. Did you know that US and India have virtually
no trade with one another? India's rise has been to a large extent internally
driven and they have more trade with the EU. When and if India should get moving,
then this will put more downward labour pressures on the West as "intelligent
jobs" move to Madras and not Milwaukee or Madrid. They have the equivalent
of engineers with MIT degrees doing sub-menial tasks - the point is simply
that when western industries can migrate and take up this talent pool, they
likely will. Equally, if they can penetrate markets like pharmaceuticals, where
they are very competitive and successful, this also brings a new dimension
into play.

What's up with the ECB and Germany?

Last week the ECB held rates at 2% in line with predictions but with the effects
of Katrina blowing stiff winds into Mr. Trichet's face. Of course the big unknown
remains the longer term effects of oil and gas prices as the EU struggles to
interpret its own data - inflationary? stagflationary? or downright deflationary?
The opinions continue to be split. With the German Bund yields dropping ever
further similar to US Treasury yields in the US, the outlook certainly does
not seem inflationary. Certainly pay rates have not been inflationary the last
years and with the advent of more and more discounter shops, IKEAs and 99 cent
shops opening I have SERIOUS doubts as to whether we can have a purely energy
driven inflation. In fact, with Winter fast approaching, heating oil and petrol
prices are rising and will likely be aggregate deflationary as consumers have
less to spend on consumption ergo 99 cent shops everywhere. Yes, the cost of
living overall is rising but is being extremely battled and dampened by static
wage earners with reduced consumption and hoarding of savings - this is why
retailers are failing. Angst / Fear. On top of this debate continues the job
markets. The job situation is poor in many countries and if it is not poor
it is because many substitute and create low-pay alternatives to improve the
statistics but leaving reality unchanged - this is giving the consumer neither
confidence nor earnings with which to increase or promote consumption. Wakey
up politicians - these are real dependencies in the real world. Consumption
and trust cannot be ordained - they must be the follow-on of logical and consequential
policies and the earnest following through of legislation set in motion. I
fear that politicians can and will not follow through on such forward-thinking
legislation either in the energy or job sectors. The state wants its tax income
regardless of rising costs elsewhere - net effect on the consumer is therefore
negative.

The latest television debate in Germany between Schröder and Merkel was
interesting and kept more or less to the issues. Schröder one more on
the sympathy line and Merkel did surprisingly well on the economic issues.
The thing to remember here is that Germany needs more and deeper reforms, especially
regarding its tax policies and state welfare transfer systems. If these key
items can be solved over the next few years then I suspect the German economy
will rebound and provide a more positive investment environment for foreigners.
Even now many continue to laud the reforms, but to my way of thinking, the
one-eyed man in the land of the blind is king. More can be done even if those
investors are coming from countries where reforms have been slow or where other
factors require a direct foreign investment into Germany. With the scent of
reforms wafting through the air, whoever wins the election would be unwise
to simply stop there - the German populace and industries are now trimmed and
braced for reform - it must now come and give the consumer and industry planning
confidence for consumption and investment respectively. The worst thing that
could happen, and which seems to be growing in likelihood, is that the election
will be won by neither majority party and thus a grand coalition being formed
by the two parties - this would be possibly tantamount to a draw and might
be the worst thing that could happen whereby each new legislative proposal
is killed or talked to death before ever reaching fruition. This really will
be an election to be watched. As in most things, HOPE remains a key factor
for the little man, industry on the other hand, may already be drawing up plan
B if things go seriously wrong. They may not go POSTAL but rather simply may
go OFFSHORE, ie. outside Germany. That will create a downward spiral of LOST
HOPE, less corporate and personal tax intake, increased deficit spending, fewer
job opportunities and of course less consumption. Where it ends nobody can
foresee.

Will the Fed raise, hold or lower rates? Nobody knows, but let us look at
a few items : even before Katrina happened the US economy was starting to falter
as the survey of Purchasing Manager's Index showed. Hence we could extrapolate
that the US economy was becoming weaker even while the "guy on the street" was
/ is still flipping condos and thinking how wonderful life really is. If now,
in the aftermath of Katrina, we can assume that most of the foreseen after
effects are likely to be priced into the markets, and the markets are standing,
still, more or less robustly, today the market was up, then I have reservations
on the Fed stopping their interest rates just here. I know this is a tricky
call but the logic of the "big picture" may be driving Greenspan more than
the isolated Katrina event. Asset prices are still high and that is what he's
been eluding to in the FOMC statements. Should a rate reversal happen here,
then asset prices and money accommodation will not be able to be brought under
control might be the thinking. And let's face it, as bad as Katrina seems to
be, the US is A LOT bigger than just New Orleans since the property / asset
bubbles is widely distributed over the nation. Hence the logical thinking would
be to be for the "good of the country" in reeling in the asset bubble and taking
care of business as foreseen prior to Katrina. Of course the psychological
factor will play a part and maybe the Bush administration will pressure the
Fed to stop rate increases in order to "give the small guy a break". That is
certainly on the table as the citizenry is appalled at how Bush and the Federal
government seemingly botched the necessary preparations via FEMA, et. al. This
is a distinct possibility. The bonds surely are not threatening inflation due
to energy as oil has now pulled back and yields lowered as the 30 year bond
price climbs.

As to gold and silver, they rose and have stabilized. The HUI has done nothing
spectacular but the gold / oil ratio has dropped sharply. In relative terms
this means that gold is cheap comparatively and may be a precursor to a Q4
rise. But the call will be made via the Fed interest rates, if they continue
rising then we simply go with that for a while and assume USD strength until
the higher rates take effect. When that happens we could imagine that gold
will then start the next leg upwards. More on the metals aspect in upcoming
Letters...

Time for a shower and breakfast. Here is an interesting article below - China
economy dead? Certainly doesn't appear so...just ask the Aussies.

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Randolph Buss, currently works in portfolio & asset
management | commodity fund advisory & management | macro investment research
as editor and publisher of his newsletter read in over 45 countries.

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